Singapore REITs - OCBC Investment 2019-03-12: A Shelter For The Doves & Uncertainties


Singapore REITs - A Shelter For The Doves & Uncertainties

Healthy 4QCY18 results

Look forward to further DPU growth

Sector preference: Retail > Hospitality > Industrial > Office

Global macroeconomic environment facing headwinds

  • A number of international agencies such as the OECD and IMF have been on a downgrading spree in the first three months of the year, slashing growth forecasts for 2019 and 2020 across the board. The weakening of both soft and hard data lends credence to their gloomy outlook.
  • OECD cut its global real GDP forecast for 2019 and 2020 by 0.2 ppt and 0.1 ppt to 3.3% and 3.4%, respectively. A more significant downward revision was slapped on the Euro area, with a 0.8 ppt and 0.4 ppt cut to 1.0% and 1.2% for 2019 and 2020, respectively. IMF also lowered its global economic forecast by the same magnitude as OECD, to 3.5% in 2019 and 3.6%% in 2020. Meanwhile, Mario Draghi, the president of the European Central Bank (ECB), highlighted that growth in the Euro area is expected to come in at 1.1% this year, versus a previous forecast of 1.7%.
  • In recent times, increasingly more S-REITs have ventured into Euro zone and the UK to expand their geographical footprint. While the expected slowdown in economic growth in the Euro zone and uncertainties surround Brexit would likely pose some risks, we note that the underlying leases of the properties acquired by S-REITs are typically long-term in nature, thus providing some visibility.
  • The fact that interest rates in the Euro zone would remain at current levels “at least through the end of 2019” would also facilitate a more favourable funding environment in EUR terms and thus provide opportunities for further inorganic growth in this region, in our view. We also see S-REITs as a useful tool for investors to ride-out the macroeconomic slowdown given their defensive attributes.

Fed funds futures rates point to a benign interest rate environment

  • Drawing reference from recent developments in the U.S., we note that the U.S. nonfarm payrolls released last week showed that Feb added only 20k jobs. This is significantly lower than consensus’ expectations for a 180k gain, and marked the weakest month of jobs creation since Sep 2017. Federal Reserve Chairman Jerome Powell’s recent speeches also painted a dovish tone, highlighting that the Committee has adopted a patient, wait-and-see-approach in light of muted inflation pressures.
  • Looking at the Fed funds futures rate, we note that there is currently a 0% probability of a rate hike in 2019, while the probability of at least one rate cut is 17.0% by the end of the year. This also implies that the base case is for the Fed funds rate to stay unchanged this year.

S-REIT managers have continued to exhibit financial prudence in their capital management

  • Despite more benign rate hike expectations in 2019, we note that the 3-month and 6-month swap offer rates (SOR) have continued their uptrend since late October last year, by approximately 33 and 17 bps to 1.94% and 1.99%, respectively. Hence, it comes as a welcome relief that REIT managers have continued to be prudent on their capital management.
  • The average gearing ratio of the S-REITs under our coverage stood at 35.5%, as at 31 Dec 2018, with 77.2% of their borrowings hedged/fixed. Meanwhile, the average debt to maturity was 3.2 years, with an average debt cost of 2.9% and interest coverage ratio of 5.1x.
  • Although interest rate swaps (IRS) have risen YTD, they are still down from their recent peak in Oct 2018. Hence, some of the S-REITs may have taken this opportunity to lock in more hedges ahead.

Valuations have tightened, but near-term trading performance may continue

  • The forward yield spread between the FTSE ST REIT Index (5.81%) and the Singapore government 10-year bond yield (2.19%) last stood at 362 bps. This is approximately one standard deviation (s.d.) below the 5-year mean of 404 bps.
  • While valuations leave nothing to be excited about at this level, in our view, we remain constructive on the near-term trading performance of S-REITs. This would be underpinned by continued benign of the rate hike trajectory by the Federal Reserve in 2019.
  • We note that during times in 2018 when the market was risk-on, the yield spread of S-REITs had compressed to 2 s.d. below the historical average. Based on the fed funds futures rate, the market is pricing in no rates hikes by end 2019.
  • In fact, the probability of a rate cut as implied by the fed funds futures rate is actually higher than the probability of a rate hike. Hence, should the Fed choose to raise rates at least once this year (given the still tight labour market), this may cause markets to relook at their assumptions and result in capital outflows from yield sensitive instruments such as REITs. Notwithstanding this risk, a rate hike, in any, would likely only happen in 2H19.
  • Maintain NEUTRAL. Our longer term preferred picks are still KEPPEL DC REIT [BUY; FV: S$1.60] and FRASERS CENTREPOINT TRUST (SGX:J69U) [BUY; FV: S$2.50]. We add ASCOTT RESIDENCE TRUST [BUY; FV: S$1.25] as a replacement for FRASERS LOGISTICS & IND TRUST (SGX:BUOU) in to gain exposure to the hospitality sector and also in light of the latter’s strong share price performance.
  • Based on Bloomberg consensus’ estimates for the entire S-REITs universe, the average potential capital upside stands at an average 6.8%. Including forecasted consensus’ average distribution yield of 6.6%, total projected returns for the sector works out to be 13.4% on average.

Wong Teck Ching Andy CFA OCBC Investment Research | Deborah Ong OCBC Investment | Joseph Ng OCBC Investment | https://www.iocbc.com/ 2019-03-12
SGX Stock Analyst Report BUY MAINTAIN BUY 1.600 SAME 1.600